TELOS CORP annual report, FY2015

Business context and reporting period

Telos Corporation’s Form 10-K covers the fiscal year ended December 31, 2015; it is an annual report, not a standalone fourth-quarter filing. Telos provides cybersecurity, secure mobility, identity-management, and IT solutions, primarily to U.S. government customers. Federal revenue was 97.3% of total revenue. About 77.0% of revenue came from fixed-price contracts.

Financial performance and liquidity

Cash and cash equivalents were only $58,000 at year-end. Borrowings under the Wells Fargo facility were $8.5 million, with $5.8 million of unused availability; the facility was secured by substantially all company assets. Capital lease obligations totaled $20.7 million. Stockholders’ deficit was $124.4 million. Redeemable preferred stock had a carrying value of $125.9 million, including $123.9 million of public preferred stock.

Material changes versus the prior year

• Revenue declined 5.4%, largely reflecting lower NETCENTS orders and reduced sales in secure mobility and IT and enterprise solutions. Services revenue fell 5.3%; product revenue fell 6.2%.
• Gross margin improved 5.8 percentage points to 25.4%, primarily from contract and solution mix, including stronger cybersecurity sales. SG&A declined 6.3% to $34.3 million.
• Operating loss narrowed, but the loss attributable to Telos widened. A $4.3 million income-tax provision replaced a $6.0 million benefit in 2014; a $7.2 million increase in the deferred-tax valuation allowance was a principal factor. Management recorded a full valuation allowance on deferred tax assets at year-end.
• Operating cash flow fell from $6.2 million to $2.7 million. Funded backlog declined to $59.2 million from $68.3 million.

Outlook, risks, contingencies, and unusual items

• Management said existing borrowing capacity was sufficient for foreseeable 2016 needs and anticipated approximately $2.1 million in 2016 capital expenditures, while noting spending could be curtailed and additional financing might be needed.
• After year-end, the credit facility was amended to mature January 1, 2017, and its total credit limit was reduced from $20 million to $10 million. The amendment increased minimum availability requirements and contemplated a $5 million equity or subordinated-debt investment by June 1, 2016; absent that investment, further availability thresholds and a fee apply. Failure to renew or replace the facility could materially harm liquidity.
• Telos lost a government contract with a funded value exceeding $45 million over the prior three years, representing approximately 11% of 2015 revenue. Its protest was denied in February 2016; Telos appealed and requested an injunction. The existing contract was scheduled to end May 22, 2016.
• The NETCENTS-2 replacement contract began accepting orders in July 2015, but procurement delays had diverted some orders to other contract vehicles. Management cited federal funding, competitive bidding, contract termination, and fixed-price cost-overrun risks.
• Two longstanding shareholder/director litigations remained pending; management said outcomes could not be predicted. The filing describes no other known ordinary-course litigation expected to materially affect results.
• Public preferred stock carries a cumulative 12% dividend; no dividends have been declared since 1991, and accrued dividends were $92.1 million at year-end. Preferred-stock obligations are subject to significant lender, legal, and contractual restrictions. A $2.5 million related-party subordinated loan bears 12% interest, with payment subordinated to the Wells Fargo facility.

Important facts for investors to verify

• Whether Telos obtained the contemplated $5 million investment and maintained sufficient borrowing availability under the amended facility.
• The outcome of the government-contract appeal and injunction request, and the resulting revenue and margin impact after May 22, 2016.
• New NETCENTS-2 task orders, backlog conversion, and the company’s ability to offset continuing U.S. government procurement and funding uncertainty.
• Cash generation and liquidity relative to debt service, capital leases, and cumulative preferred-stock obligations.
• Future tax-asset realization assumptions and potential goodwill impairment: no goodwill impairment was recorded, but management noted that contract losses or missed growth projections could trigger one.

The independent auditor issued an unqualified opinion on the consolidated financial statements. Management reported effective disclosure controls and internal control over financial reporting as of December 31, 2015.